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Fireman's Fund Mortgage Corp. v. Severance (9/11/92), 838 P 2d 790
<![CDATA[
NOTICE: This opinion is subject to formal correction
before publication in the Pacific Reporter. Readers are
requested to bring typographical or other formal errors to
the attention of the Clerk of the Appellate Courts, 303 K
Street, Anchorage, Alaska 99501, in order that corrections
may be made prior to permanent publication.
THE SUPREME COURT OF THE STATE OF ALASKA
FIREMAN'S FUND MORTGAGE )
CORPORATION (as agent for )
Alaska Housing Finance )
Corporation), )
)
Appellant, ) File No. S-4298
)
v. ) 3AN 89 10157 CI
)
ALLSTATE INSURANCE COMPANY; ) O P I N I O N
FIRST NATIONAL BANK OF )
ANCHORAGE, AND GARY SEVERANCE, )
Personal Representative of the )
Estate of Marjorie Severance )
Hoover, )
)
Appellees. ) [No. 3883 - September 11,
1992]
________________________________)
Appeal from the Superior Court of the State
of Alaska, Third Judicial District,
Anchorage, Milton M. Souter, Judge.
Appearances: Richard N. Ullstrom, Routh,
Crabtree & Harbour, Anchorage, for Appellant.
Ronald E. Noel, and Joseph S. Slusser,
Hughes, Thorsness, Gantz, Powell & Brundin,
Fairbanks, for Appellees.
Before: Rabinowitz, Chief Justice, Burke,
Matthews, Compton and Moore, Justices.
BURKE, Justice.
In this interpleader action, Fireman's Fund Mortgage
Corporation (Fireman's Fund) and First National Bank of Anchorage
(First National) each claim $28,175 which was interpled by
Allstate Insurance Company.1 The sum represents Allstate's
obligation under a fire insurance policy which it issued to cover
the Fairbanks property involved in this case. Fireman's Fund
held a first deed of trust on the fire-damaged property, and
First National held a second deed of trust. On cross-motions for
summary judgment, the superior court granted First National's
motion and awarded it the amount interpled plus interest. We
reverse.
I. FACTS & PROCEEDINGS
Fireman's Fund administered a deed of trust for Alaska
Housing Finance Corporation (AHFC) on property located in
Fairbanks. First National held a second deed of trust on the
property securing a loan in the amount of $147,000. At all
relevant times, the title owner of the property was Marjorie
Severance-Hoover.
Due to a default on the loan secured by its first deed
of trust, Fireman's Fund began non-judicial foreclosure
proceedings by recording a Notice of Default in April 1989. A
foreclosure sale occurred on August 3, 1989. At the time of the
sale, the principal owing on the Fireman's Fund loan was
$93,996.56 (not including accrued interest and foreclosure fees).
Fireman's Fund bought the property on behalf of AHFC with an
offset bid of $75,486.15. Several days later, Fireman's Fund
discovered for the first time that the house on the property had
been virtually destroyed by fire just a few hours before the
start of the sale.2
The trust deeds required Ms. Severance to maintain fire
insurance on the property for its "full insurable value." Two
fire insurance policies covered the property at the time of the
fire: one issued by Allstate and another issued by American
Bankers Insurance (ABI). Both policies named Fireman's Fund as
mortgagee. The Allstate policy contained a "standard"or "union"
mortgagee clause which provided that the policy would "not be
invalidated . . . by the commencement of foreclosure proceedings
. . . by virtue of any mortgage or deed of trust." It further
provided:
Should legal title to and beneficial
ownership of any of the property covered
under this policy become vested in the
Lender . . . insurance under this policy
shall continue for the term thereof for the
benefit of the Lender . . . .
First National was not named as a loss payee in either policy.
However, Allstate has admitted, and Fireman's Fund does not
contest, that First National has a lender's interest in the
subject property making it a loss payee under the policy.
After the fire, the two insurers ordered an appraisal
of the property. The appraiser determined that the market value
of the property in its undamaged state was $86,000. The
appraiser then estimated that the fire had reduced the property's
value by $58,000 and placed its post-fire market value at $28,000
for land and undamaged site improvements.
Based on this appraisal, the two insurers pro-rated
their liability under the policies. American Bankers Insurance
paid its pro-rated share directly to Fireman's Fund. Allstate
initially tendered a check for $28,175.00 payable jointly to Ms.
Severance and Fireman's Fund as full settlement for its pro-rated
share. However in December 1989, after the Severance estate3 and
First National made competing claims to the insurance proceeds,
Allstate stopped payment on the check and filed this interpleader
action. In February 1990, Allstate deposited the $28,175
with the clerk of the court. First National moved for summary
judgment seeking not only the amount interpled by Allstate but a
sum representing the entire amount of the loss. After a cross-
motion for summary judgment by Fireman's Fund, the superior court
granted First National's motion and awarded it the interpled
funds plus interest. The trial judge only offered two citations
without text or explanation to support his decision: Bohn v.
Louisiana Farm Bureau Mutual Ins. Co., 482 So. 2d 843, 851 (La.
App. 1986) and Stormont v. Weatherby, 4FA-86-01771 Civ. (Alaska
Super., 4th Dist., Fairbanks, April 20, 1987) (Decision of
Superior Court Judge Jay Hodges). This appeal followed.
II. DISCUSSION
The question presented in this case is one of first
impression for this court.4 First National apparently persuaded
the trial judge below that Fireman's Fund's decision to non-
judicially foreclose on the Fairbanks property divested it of the
right to collect the insurance proceeds.5 On appeal, Fireman's
Fund argues that it is entitled to all of the insurance proceeds
because the unpaid debt on its first deed of trust was not fully
discharged by foreclosure. Fireman's Fund contends that its
offset bid should not be deemed a satisfaction of its debt
divesting it of the right to collect the insurance proceeds
because the bid reflects the property's value in its undamaged
state. It maintains that, as senior lienholder, the company is
entitled to fully satisfy its debt out of the insurance proceeds
before a junior lienholder may receive anything. It also
maintains that the insurance claims adjustment process will guard
against a first mortgagee receiving more than its due. We agree
with Fireman's Fund's first contention regarding discharge by
foreclosure. We will address its second contention concerning
the effect of the offset bid in the next section.
1. Alaska Statute 34.20.100 does not operate to extinguish
a secured debt upon foreclosure as a matter of law.
As a preliminary matter, we note that the authority
cited by the trial judge may be distinguished on the facts and
therefore fails to support the court's decision. In Stormont,
the superior court held that a non-judicial foreclosure sale
subsequent to a fire loss extinguishes the underlying mortgage
and therefore divests the mortgagee of the right to collect
insurance proceeds. Stormont, slip op. at 3. However, this
holding was explicitly based on the fact that the mortgagee had
bid the full amount due on the mortgage at the foreclosure sale.
The trial judge observed: "since [the mortgagee] has been paid in-
full, he is not entitled to the insurance proceeds." Id.
(emphasis added).
In Bohn, a mortgagee, who was named as loss payee under
a "standard"mortgagee clause, sought fire insurance proceeds for
a fire damaged property which it purchased at its own foreclosure
sale subsequent to the fire's occurrence. Bohn, 482 So. 2d at 844-
46. The mortgagor sought the same proceeds. Id. The Bohn court
first noted that Louisiana's antideficiency statute provides that
if a mortgagee elects to satisfy its debt through a foreclosure
sale without the benefit of an appraisal and the sale proceeds
are insufficient to satisfy the debt, "the debt nevertheless
shall stand fully satisfied and discharged in so far as it
constitutes a personal obligation of the debtor." La. Rev. Stat.
Ann. 13:4106; Id. at 848. The court then reasoned that:
the mortgagee has a vested interest in
the [insurance] proceeds as of the time of
loss. However, when the mortgagee forecloses
on the debtor's property without benefit of
appraisal, the debt is extinguished insofar
as it exists as a personal obligation of the
debtor under the Deficiency Judgment Act.
Therefore, the mortgagee's interest in the
proceeds, which is the balance of the
mortgage debt, is likewise reduced to zero.
At that point, the entire fund representing
the insurance proceeds is the property of the
insured. Thus, an action by the mortgagee
for recovery of the insurance proceeds
subsequent to a foreclosure without benefit
of appraisal is an action against property of
the mortgage debtor, and is consequently
precluded by the Deficiency Judgment Act.
Id. at 851 (emphasis added).
The holding in Bohn supports the proposition that a
mortgagor may, under Louisiana's antideficiency act, recover fire
insurance proceeds if a mortgagee forecloses without appraisal
subsequent to a fire loss. However, both the language of
Louisiana's statute and the rationale of the Bohn opinion
indicate that a second mortgagee may not simply step into the
mortgagor's shoes and recover the proceeds following a
foreclosure by the first mortgagee. In other words, it does not
follow that a second mortgagee is afforded the same statutory
protections as the mortgagor, nor does it follow that a first
mortgagee's interest in the insurance proceeds is extinguished as
to all claimants.6
Furthermore, Fireman's Fund persuasively argues that
Alaska's antideficiency statute, AS 34.20.100, is fundamentally
different from Louisiana's statute in that it does not operate to
extinguish the underlying debt but merely eliminates certain
types of remedies against specific classes of debtors.7 AS
34.20.100 (1990) provides:
When a sale is made by a trustee under a
deed of trust, as authorized by AS 34.20.070-
34.20.130 [statutes governing non-judicial
foreclosure sales], no other or further
action or proceeding may be taken nor
judgment entered against the maker or the
surety or guarantor of the maker, on the
obligation secured by the deed of trust for a
deficiency.
In Hull v. Alaska Federal Sav. & Loan Ass'n, 658 P.2d
122 (Alaska 1983), we held that although the antideficiency
statute:
limits the creditor's rights to pursue
further legal action or process against his
debtor for any deficiency in the obligation
following a non-judicial foreclosure of the
property[, t]he limitation does not bar the
retention of additional security pledged on
the obligation.
Id. at 125. While we recognize that Hull is not precisely on
point because fire insurance proceeds are generally considered
substitute security rather than additional security, the case
supports Fireman's Fund's view that a non-judicial foreclosure
sale does not operate to extinguish the underlying debt.
It is also significant that the competing claimants in
the present case are first and second mortgagees rather than a
mortgagor and a mortgagee as in Hull.
In Hull, we stated that the "Alaska anti-deficiency
statute, like the post-depression enactments of many other
states, was aimed at relieving the plight of debtors whose
obligations were secured by mortgages or other security interests
in land." Id. at 124 n.3 (emphasis added). The protections of
this statute are aimed at the mortgagor and may not be invoked by
a junior lienor who knowingly took a lesser security interest.
We have stated that "[t]he effect of the trustee's sale was to
discharge all [the mortgagor's] obligations under the note."
Smith v. Shortall, 732 P.2d 548, 549 (Alaska 1987). However, the
fact that the mortgagor's obligation is discharged does not mean
that the underlying debt is extinguished for all purposes.
Finally, the statute's plain language supports the
conclusion that the loan obligation is not completely
extinguished as a matter of law at the time of a non-judicial
foreclosure sale. The statute contemplates the survival of a
loan "obligation"following the sale, but precludes the lender
from seeking any "deficiency"on this obligation either from the
debtor or from the debtor's guarantor.
2. Fireman's Fund is bound by its offset bid but may seek
reformation of the sales contract given the equities of
this case.
Fireman's Fund was protected by a "standard"mortgagee
clause in the two fire insurance policies. A standard mortgagee
clause in an insurance contract provides a mortgagee with much
greater protection than a "simple"loss payee clause which merely
designates the mortgagee as an alternative payee under the
policy. Under a standard mortgagee clause, a mortgagor's breach
of the insurance contract will not bar recovery by the mortgagee.
Bohn, 482 So. 2d at 850 (quoting Couch on Insurance Law 42:694
(2d ed. 1963)). The standard clause constitutes a separate and
independent contract between the mortgagee and the insurance
company which is "measured by the terms of the mortgage clause
itself."8 Id.
Fireman's Fund acknowledges that most courts have held
that a subsequent foreclosure by a mortgagee either partially or
completely divests the mortgagee of its rights under the
insurance contract.9 See Whitestone Sav. & Loan Ass'n v. Allstate
Ins. Co., 270 N.E.2d 694 (N.Y. App. 1971); Moke v. Whitestone
Sav. & Loan Ass'n, 370 N.Y.S.2d 377 (N.Y. Sup. 1975); see
generally 5A John A. Appleman & Jean Appleman, Insurance Law &
Practice 3403-04 at 299 (1990). However, Fireman's Fund points
out that the courts that espouse this rule are primarily
concerned with unjust enrichment and assume that the mortgagee
knowingly and voluntarily elected to seek the property in lieu of
the proceeds or made an offset bid on the property aware of its
damaged condition. The rule is therefore:
intended to prevent a creditor from
receiving a double payment. The creditor's
interest in the insurance proceeds is
recognized as security for the payment of the
debt. The insurance is an alternative source
of payment and once the debt is paid by some
other means any right to the insurance is
thereby extinguished.
Calvert Fire Ins. Co. v. Environs Development Corp., 601 F.2d
851, 856 (5th Cir. 1979).
Although not specifically discussing "standard"
mortgagee clauses or the effect of subsequent foreclosure, we
have made a similar observation in Moran v. Kenai Towing &
Salvage, Inc., 523 P.2d 1237, 1239-40 (Alaska 1974):
The great weight of authority
answers that a mortgagee may satisfy his
secured debt from the proceeds [of the fire
insurance policy], but if the indebtedness
does not exhaust the proceeds, the balance
shall be paid to the mortgagor. Were the
rule otherwise, the mortgagee would be
unjustly enriched at the expense of the
mortgagor, who bears the ultimate burden of
paying for the insurance. The purpose of
requiring insurance coverage . . . is to
protect the integrity of the asset which is
hypothecated to the mortgagee to secure
repayment of the underlying debt.
Moran, 523 P.2d at 1239-40. Clearly, the rationale behind these
cases is the desire to prevent a double recovery. Thus Fireman's
Fund is prohibited, under the rationale in Moran, from receiving
more insurance proceeds than required to satisfy its outstanding
debt.
The next issue which must be resolved is the amount of
Fireman's Fund's outstanding debt following the foreclosure sale.10
Fireman's Fund argues that we should disregard its offset bid
because the bid was made in ignorance of the property's damaged
condition. Fireman's Fund points out that the appraised value of
the fire-damaged property ($28,000.00), the ABI insurance
proceeds ($33,564.10) and Allstate proceeds ($28,175.00) combined
come to several thousand dollars less than the mortgage
indebtedness of $93,996.56 which remained on the first deed of
trust. Therefore, Fireman's Fund argues that, in real terms, it
is not getting more than its due.
We recognize the validity of Fireman's Fund's economic
argument and have some reservations about holding it to an offset
bid made in ignorance of the property's condition merely to
preserve what is essentially a legal fiction (i.e. that the
offset bid represents a mortgagee's actual payment for the
property).11 However, we believe it would be a mistake to simply
disregard the offset bid in this situation, as Fireman's Fund
urges us to do. If a mortgagee's offset bid is not really an
offset of the outstanding debt, how can the remaining
indebtedness be determined for purposes of pursuing additional
security, as in Hull? See Hull, 658 P.2d at 122.
Fireman's Fund had a contractual right to the insurance
proceeds which vested at the time of the fire. See Atlas
Assurance Co. v Mistic, 822 P.2d 897, 903 (Alaska 1991); see also
Corbin v. Aetna Life & Cas. Co. 447 F. Supp. 646, 650 (N.D. Ga.
1978). The subsequent foreclosure did not change this
contractual right. However, at the foreclosure sale a few hours
later, Fireman's Fund essentially "spent"$75,486.15 of its total
indebtedness in making its offset bid. This offset bid left
Fireman's Fund with an outstanding indebtedness of approximately
$18,500 plus interest and foreclosure costs. Under Moran and the
great weight of authority, Fireman's Fund is only entitled to
recover an amount of the insurance proceeds sufficient to satisfy
this outstanding debt. Any remaining proceeds must be passed on
to junior lienholders and/or the mortgagor as their interests
appear.
Nonetheless, our holding today does not mean that
Fireman's Fund is left without legal recourse to avoid this
result. Given the facts of this case,12 it would be plainly
unjust to leave Fireman's Fund with a fire-damaged property and
yet deprive it of the insurance proceeds "which stands in place
of the lost portion of the property."See Tech Land Dev. v. South
Carolina Ins., 291 S.E.2d 821, 823-24 (N.C. App. 1982) (quoting
Malvaney v. Yager, 54 P.2d 135, 139 (Mont. 1936) (citations
omitted)).
The best solution is to allow Fireman's Fund to seek
reformation of the foreclosure sales contract to replace the
$75,486.15 purchase price with a price more reflective of the
actual market value of the property at the time of sale.
Traditionally, reformation is a tool courts use to correct what
are essentially errors in the drafting of a contract so as
conform the written agreement to the "clear intention of the
parties." See Oaksmith v. Brusich, 774 P.2d 191, 197 (Alaska
1989). We have also held that "[r]eformation is appropriate
where, by reason of mutual mistake, the written agreement does
not accurately reflect the bargain intended by the parties."
Riley v. Northern Commercial Co., Mach. Div., 648 P.2d 961, 969
(Alaska 1982).
However, we have also recognized a more expansive use
of the tool of reformation to allow our courts to alter the terms
of a contract when the interests of justice so require. In
Vockner v. Erikson, 712 P.2d 379 (Alaska 1986), we upheld a
superior court's reformation of a land sales contract based on
the finding of unconscionability. Id. at 383. We noted that
"the aim of reformation in these circumstances is to bring the
contract in conformity with minimal standards of
conscionability." Id. at 384.
The present case falls somewhere between the
traditional use of reformation and its more expansive use based
on an examination of the equities involved. On the one hand, all
parties to the foreclosure sale where operating under the belief
that the subject property was undamaged at the time of sale.
Fireman's Fund's bid was therefore based on a mutual mistake as
to the condition of the property. Fireman's Fund was bargaining
for an undamaged property and did not obtain the benefit of its
bargain. Reformation of the sales price is therefore
appropriate. Also, from an equity standpoint, it is significant
that this was a foreclosure sale in which the mortgagee operating
the sale purchased the foreclosed property. Fireman's Fund was,
in essence, both the buyer and seller in the transaction.
The somewhat unusual features of this case make
reformation a sensible remedy. We therefore conclude that
Fireman's Fund may seek reformation upon remand of this case to
the superior court. Even so, Fireman's Fund has the burden of
showing by clear and convincing evidence that reformation is
warranted. See Oaksmith, 774 P.2d at 197. At this proceeding,
all interested parties should be allowed to present evidence as
to Fireman's Fund's knowledge of the condition of the property at
the time of sale and any other related matters.
III. CONCLUSION
On the undisputed facts presented, we hold that
Fireman's Fund is not precluded by AS 34.20.100 (1990) from
satisfying its outstanding debt from available insurance proceeds
even though it purchased the fire-damaged property at its own
foreclosure sale. However, Fireman's Fund must be held to its
offset bid of $75,486.15 which would entitle it to only so much
of the insurance proceeds as required to pay off the remaining
debt, approximately $18,500 plus interest and foreclosure costs.
The remaining proceeds should go to First National and/or the
Severance estate as their interests appear.13 We further hold
that Fireman's Fund is entitled to seek reformation of the
purchase price in the sales contract.
REVERSED and REMANDED for further proceedings
consistent with this opinion.
_______________________________
1. In this appeal, Fireman's Fund is acting as agent for
Alaska Housing Finance Corporation who was beneficiary of a first
deed of trust on the property in question. However, for ease of
reference, we have adopted the convention of the parties and
refer to Fireman's Fund as if it were the real party in interest.
2. First National concedes Fireman's Fund's lack of
knowledge at the time of sale only for the purpose of its summary
judgment motion because it believes this fact is irrelevant to
the legal question presented. If this turns out not to be the
case, First National requests a hearing to determine Fireman's
Fund's actual knowledge. The general rule is that:
a party moving for summary judgment
concedes the absence of a factual issue and
the truth of the nonmoving party's
allegations only for purposes of his own
motion.
10A Charles A. Wright & Arthur R. Miller, Federal Practice and
Procedure 2720 at 20 (1983). Therefore, as a strictly
procedural matter, First National has not waived its right to
contest this issue. However, the undisputed facts disclosed in
the record appear capable of supporting only one conclusion; that
Fireman's Fund made its offset bid with no knowledge of the fire.
3. Ms. Severance-Hoover died during the pendency of this
action and her estate is being represented by Gary Severance.
However, after initially filing an answer to the interpleader
complaint, the estate has taken no further record action in the
case and has not appealed the trial court's decision.
4. Since the parties do not dispute the facts for purposes
of their summary judgment motions, a question of law is
presented. We review a question of law using our independent
judgment and adopt the rule which is most persuasive in light of
precedent, reason and policy. Guin v. Ha, 591 P.2d 1281 (Alaska
1978).
5. Under state law, a mortgagee has limited options when a
mortgagor defaults on a loan, and, as First National points out,
each option has its own advantages and disadvantages. A
mortgagee may 1) sue on the note itself, 2) judicially foreclose
on the property and preserve the right to a deficiency judgment
subject to a mortgagor's right of redemption, or 3) nonjudicially
foreclose on the property and give up any deficiency judgment but
also avoid redemption rights and court costs. See Moening v.
Alaska Mutual Bank, 751 P.2d 5, 7-8 (Alaska 1988). First
National maintains, based on its reading of the relevant statute,
that by choosing the last option, Fireman's Fund's debt was
extinguished at the time of the foreclosure sale because it had
fully satisfied its debt as a matter of law. Therefore, First
National concludes, Fireman's Fund's right to the insurance
proceeds was also extinguished.
6. In addition to factual differences in these cases, we
are, of course, free to adopt our own rule even if contrary to
the reasoning employed by these persuasive authorities.
7. All the cases cited by First National involve anti
deficiency statutes more akin to Louisiana's act than to AS
34.20.100. See e.g. Moke Realty v. Whitestone Sav. & Loan Ass'n,
370 N.Y.S.2d 377, 380 (N.Y. Sup. 1975) (result similar to Bohn;
N.Y. antideficiency statute provides that failure to move for
deficiency judgment within 90 days of foreclosure sale and
delivery of deed means "the proceeds of the sale regardless of
amount shall be deemed to be in full satisfaction of the mortgage
debt").
8. Fireman's Fund relies on this premise to argue that its
reasonable expectations of coverage will be defeated if its
foreclosure bid divests it of the right to collect the proceeds.
The clause itself specifically states that the policy will not be
invalidated as to the lender payee as a result of any foreclosure
and also contemplates that legal title may vest in the lender
without causing an interruption in coverage. It is well
recognized that the right to insurance proceeds vests at the time
of loss. See Atlas Assurance Co. v. Mistic, 822 P.2d 897, 903
(Alaska 1991); see also Corbin v. Aetna Life & Cas. Co. 447 F.
Supp. 646, 650 (N.D. Ga. 1978) (citing and quoting 5a John A.
Appleman & Jean Appleman, Insurance Law and Practice, 3403 at
300 (rev'd ed. 1970)). Therefore some courts have held that a
subsequent foreclosure will not affect a mortgagee's rights to
the insurance proceeds at least when the controversy involves an
insurer and a mortgagee/claimant. See Corbin, 447 F. Supp. at 651-
52.
However, in the present case, Allstate acknowledges its
obligation under the contract and the dispute is between
competing claimants to the proceeds. It is the equitable
relationship between the parties that is at issue not an
interpretation of the contract provisions. See Moran v. Kenai
Towing and Salvage, Inc. 523 P.2d 1237, 1240 n.2 (Alaska 1974)
(in a dispute involving a mortgagor and a mortgagee's competing
claims to insurance proceeds, we concluded that the statute
governing insurance contracts was not directly relevant; instead
we focused on the equitable relationship between the parties).
Therefore, Fireman's Fund's argument on this point has little
merit.
9. The courts are split on whether a mortgagee's offset
bid for less than the amount of its outstanding debt operates to
completely extinguish the debt or merely reduces the mortgagee's
insurable interest in the property and by extension reduces its
entitlement to the insurance proceeds. Some, like the Bohn court,
rely on their antideficiency statute to conclude that even a
partial bid completely extinguishes the debt. See e.g. Coppotelli
v. Insurance Co. of North America, 484 F. Supp. 1327, 1329
(E.D.N.Y. 1980). Others follow the rule that "subsequent partial
or full extinguishment of the debt giving rise to the insurable
interest will reduce the loss-payee's interest in the proceeds to
the extent the debt has been satisfied."See Calvert Fire Ins.
Co. v. Environs Development Corp. 601 F.2d 851, 856 (5th Cir.
1979) (providing extensive list of case citations as support for
rule).
10. The North Carolina Court of Appeals lays out the
approach typically taken by courts to resolve this type of
dispute:
[C]ourts emphasize the sequence of
events. They distinguish between foreclosure-
after-loss and foreclosure-before-loss. When
insured property is damaged prior to
foreclosure, courts allow the purchasing
mortgagee to retain under the mortgage clause
those proceeds amounting to any deficiency
after foreclosure. The mortgagor recovers
the remainder of the proceeds. The courts
conclude that once the deficiency is
satisfied, the mortgagee's additional
recovery of proceeds representing undamaged
property would amount to unjust enrichment
since its bid represented the value of
damaged property.
Where the damage occurs after
approval of the foreclosure sale and before
expiration of the mortgagor's right to
redeem, courts have allowed the purchasing
mortgagee to recover all the insurance
proceeds should the mortgagor fail to redeem
within the time period. The courts point out
that the mortgagee's bid represented the
property in an undamaged state. The
mortgagee is thus "entitled to what remains
and to the money which stands in place of the
lost portion of the property which he
purchased."
Tech Land Dev. v. South Carolina Ins., 291 S.E.2d 821, 823-24
(N.C. App. 1982) (quoting Malvaney v. Yager, 54 P.2d 135, 139
(Mont. 1936) (citations omitted, emphasis in original). Here,
the fire occurred only hours before the sale, and Fireman's Fund
had no actual or constructive notice of the damage. These
unusual facts make a straightforward application of the
traditional rule problematic.
11. Courts have gone both ways on this question based on
their view of the effect of foreclosure and the particular facts
presented. The Ninth Circuit took a strictly technical approach
in Universal Mortgage Co. v. Prudential Ins. Co., 799 F.2d 458
(9th Cir. 1986). Applying California law, the circuit court
noted that a "full or partial extinguishment of a mortgage debt,
whether prior or subsequent to loss, precludes, to the extent
thereof, any recovery on a loss by the loss payable mortgagee."
Id. at 460. The circuit court then adopted the district court's
explanation that:
actual or constructive knowledge [of the
property's condition] is irrelevant to the
policy or application of the rule. Neither
the true value of the subject property nor
the conduct of the beneficiary controls the
impact of a full credit bid. Once the debt
was extinguished at the time of the bid, so
was [mortgagee's] insurable interest.
Id. (quoting the district court). The Connecticut Supreme Court
takes an approach more reflective of economic reality. See
Burritt Mut. Sav. Bank v. Transamerica Ins., 428 A.2d 333 (Conn.
1980). The court first recognized that "inequitable results may
be produced if a court regards the debt as wholly satisfied when
the mortgagee has in fact received less than full payment." Id.
at 338 (quoting Keeton, Basic Text on Insurance Law 188, n.4
(1971)). Since the record failed to disclose the actual value of
the damaged property at the time the mortgagee acquired the deed
through strict foreclosure, the court remanded the case for a
determination whether "the appropriation by strict foreclosure of
the mortgaged property has equitably satisfied the mortgage
debt." Id. at 339.
12. The operative facts are that Fireman's Fund initiated
non-judicial foreclosure proceedings before the fire occurred and
had no actual or constructive knowledge of the property damage at
the time it made its offset bid. The very short period of time
between the fire and the foreclosure sale goes to the issue of
constructive knowledge and obviously weighs in Fireman's Fund's
favor. If there were other bidders at the foreclosure who were
outbid by Fireman's Fund's use of its offset bid rights, the
equities might be balanced differently.
13. Fireman's Fund has raised an alternative basis for
reversal of the trial court's decision. Under Alaska's deed of
trust statutes, if a senior lienholder provides notice of a
pending non-judicial foreclosure sale to junior lienholders, the
sale extinguishes the junior lienholders' interest. AS
34.20.090(a)-(c); See Nystrom v. Buckhorn Homes, Inc., 778 P.2d
1115, 1124-25 (Alaska 1989). One fact, which the record does not
reveal, is whether First National had notice of the sale.
Assuming it did, First National's failure to protect its interest
before the sale would eliminate its insurable interest in the
property had the fire taken place after the sale. However,
because the fire occurred prior to the sale, First National
retains a secondary interest in the fire insurance proceeds. See
supra, p.16 (rights to fire insurance proceeds vest at time of
fire).
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